Thursday, June 11, 2009

"So what exactly is this economy business anyhow?" Pt. III (home stretch!)

In my last installment of on the rudiments of economics, I'll discuss the five Key Principles of Economics, those things that are self-evident truths that we understand and accept in the economic world like we do gravity or fire being hot. I'll touch on them here but will reference them more and more as time goes on because economic analysis keeps coming back to them. Think of them as the foundation on which economies are built.

-The Principle of Opportunity Cost is based on the principle that economics is all about analyzing trade-offs. The opportunity cost of something is what you have to sacrifice to get it. If you pay $100 for tickets to the next sweet U2 show, then that is $100 you aren't spending on something else, like CD's from a bunch of other bands that are infinitely better, or donations to Sally Struthers, or approximately 20 Shamwows. Additionally, we can apply it to time as well since time is a limited resource too. For every U2 concert you go to, that's less time you have to look at porn on the internet, or punch yourself fervently and repeatedly in the crotch (though efficient people will realize that the latter activity is very similar to going to the concert in the first place).

-The Marginal Principle is simply thinking in marginal terms and the results of small incremental changes in activity. "Marginal Benefit" is the additional result of an increase in an activity and "Marginal Cost" is the additional cost of said increase in activity. If U2 could raise the price of tickets and sell them all by playing an extra hour, their marginal benefit (more ticket revenue) exceeds their marginal cost (less time lamenting the social injustice in the world) and it would make sense for them to pursue this. The level of the increase in an activity should always continue until the marginal cost equals the marginal benefit. Thinking at the margin is basically "fine-tuning" the decision-making process to the point where we maximize the benefit from our choices.

-The Principle of Diminishing Returns is the principle that states the number of inputs will eventually cause a reduction in outputs that decrease at an increasing rate. At some point U2 playing long concerts will actually cause the increase of ticket sales to slow down as they extend their sets because at some point, the allure of listening to 12-hours of Bono keening into a microphone stops being worth the additional cost of the ticket. So for every additional hour they spend playing (the input), actually causes ticket sales to slow down (the output). They still might sell more tickets for each additional hour they play, but not at the rate they were selling them when they decided to only play for two hours. And, at some point, it will start costing them more to play than they will generate in revenue.

-The Principle of Voluntary Exchange is the big one that the socialist thinkers overlook a lot. This is when two individuals make an exchange that makes both individuals better off. Everything from wages people are paid to the price of goods falls under this and you'll hear me talk about it a lot. If U2 is charging $100 a ticket for their two-hour show of rockin' tunes, they are better off for having sold you the ticket and the concert-goer is better off for having an enjoyable experience of delay-drenched guitar rock and an increased awareness of social injustices going on throughout our world. Or, to put it into more tangible terms, when you buy a pound of hamburger at Wal-mart, Wal-mart is better off with the money you give them than they were with the pound of meat slowly decaying in their meatcase and you are better off with a pound of cow meat than you were with the money because you can't actually eat money. The cow, incidentally, has benefitted nothing from this exchange.

-The Real-Nominal Principle is the principle that states what matters to people is the real value of money or income and not its "face" value. The "1" on the dollar bill means nothing to you other than what it will actually buy you. In 1913 that dollar in your pocket bought you a dollar's worth of goods. Today it will buy you $0.04 worth of goods. (or a 100-dollar bill bought you a U2 ticket but back then it would have bought you 25 U2 tickets--fun for the whole family!). Obviously we are more concerned with what our money will actually buy us as opposed to what the number on the currency says. This is important to remember too because if the price of your goods goes up by 4% in a year, and you get a 3% raise that year, you're actually worse off this year than last year. This is part of the "money illusion" and I'll be bringing that concept up later on down the road.

So that concludes the fundamentals. Now you're ready to strap on your thinking helmets and follow me down through the maelstrom of free market economics and why freer markets mean freer people overall and how these uncontrolled forces actually work better and more naturally on their own than when we try to tinker with them ourselves. See you soon!